Economic Freedom of the World

The annual survey Economic Freedom of the World is an indicator produced by the Libertarian Fraser Institute, a Canadian think tank which attempts to measure the degree of economic freedom in the world's nations. This indicator has been used in peer-reviewed studies some of which have found a range of beneficial effects of more economic freedom,[1] but countries with higher economic freedom suffered more in output growth during the late-2000s financial crisis.[2]

Economic Freedom of the World index has been more widely used than any other measure of economic freedom, because of its coverage of a longer time period.[3]

Contents

One of the earliest measures of economic freedom was developed by Freedom House, which has done extensive work on the measurement of political and cultural freedom. This measure incorporated a range of indicators including freedom to establish a business and freedom of union organisation.

Voluntary exchange coordinated by markets rather than allocation via the political process

Freedom to enter and compete in markets

Protection of persons and their property from aggression by others

The 2005 report states "When the functions of the minimal state—protection of people and their property from the actions of aggressors, enforcement of contracts, and provision of the limited set of public goods like roads, flood control projects, and money of stable value—are performed well, but the government does little else, a country’s rating on the EFW summary index will be high. Correspondingly, as government expenditures increase and regulations expand, a country’s rating will decline."

In practice, the index measures:

Size of Government: Expenditures, Taxes, and Enterprises

Legal Structure and Security of Property Rights

Access to Sound Money

Freedom to Trade Internationally

Regulation of Credit, Labor, and Business

The report uses 42 distinct variables, from for example the World Bank, to measure this. Some examples: tax rates, degree of juridical independence, inflation rates, costs of importing, and regulated prices. Each of the 5 areas above is given equal weight in the final score.

Charts showing economic freedom, as defined in Economic Freedom of the World, and various other indicators. The red bars shows nations with less economic freedom, the green bars those with more.

Hundreds of peer-reviewed articles have used the index and has been used in economic research, political science, and environmental research.[4][5]

Economic freedom has been shown to correlate strongly with higher average income per person, higher income of the poorest 10%, higher life expectancy, higher literacy, lower infant mortality, higher access to water sources and less corruption. The share of income in percent going to the poorest 10% is the same for both more and less economically free countries.[6]

The people living in the top one-fifth of the most free countries enjoy an average income of $23,450 and a growth rate in the 1990s of 2.56 percent per year; in contrast, the bottom one-fifth in the rankings had an average income of just $2,556 and a -0.85 percent growth rate in the 1990s. The poorest 10 percent of the population have an average income of just $728 in the least free countries compared with over $7,000 in the most free countries. The life expectancy of people living in the most free nations is 20 years longer than for people in the least free countries.[7]

Higher economic freedom, as measured by both the Heritage and the Fraser indices, correlates strongly with higher self-reported happiness[8] and is significant in preventing wars. Economic freedom is around 54 times more effective than democracy (as measured by Democracy Score) in diminishing violent conﬂict.[9]

Regarding environmental health, studies have found no or a positive effect. More important may be the Kuznets curve. Most environmental health indicators, such as water and air pollution show an inverted U-shape. Meaning in the beginning of economic development, little weight is given to environmental concerns, raising pollution along with industrialization. After a threshold, when basic physical needs are met and a middle class is established, interest in a clean environment rises, reversing the trend.[10]

Studies show that more economic freedom is the cause of beneficial effects[11] and that Economic Freedom of the World was used for most of the research, partly because Index of Economic Freedom only goes back to 1995 and because it uses more subjective variables.

Economic Freedom of the World 2005 states that the world economic freedom score has grown considerably in recent decades. The average score has increased from 5.17 in 1985 to 6.4 in the most recent available year. Of the nations in 1985, 95 nations increased their score, seven saw a decline, and six were unchanged.

A related index for Chinese provinces is followed by both Chinese scholars and policy makers. There is also a network of institutions in 59 different nations that use the index to promote free market ideas.[12]

The claimed correlation between economic freedom and growth has been critically analysed by a number of studies. De Haan and Siermann find that the relationship is not robust,[13] while Heckelman and Stroup argue that the weighting procedure used in the construction of the index is arbitrary.[14] They examine the components of the index individually and find that many – including a low top marginal tax rate – are negatively, rather than positively correlated with economic growth.

A frequent criticism is that China, and other developing nations, have high growth rates but relatively low economic freedom. Developing nations can have higher growth rates than developed nations, as they have cheap labor and can import investment, technology and organizational skills from rich countries.

Although the World Bank does not believe that laissez-faire policies, if they allow large inequalities of wealth to develop, are an effective way to achieve this goal, it is a strong supporter of the importance of economic growth for reducing poverty. It argues that an overview of many studies shows that:.[16]

Growth is fundamental for poverty reduction, and in principle growth as such does not seem to affect inequality

Growth accompanied by a more egalitarian distribution of wealth is better than growth alone